Back in the early days of launching my first company, I must admit I had no idea what I was doing. Sure, I knew how to do all the technical work, but when it came to identifying my ‘ideal client’, well, I had no idea what they might look like.
And when it came to acquiring new clients, the truth is I was far from picky. I didn’t care who they were or what industry they hailed from, as long as their wallets weren’t empty. My primary concern was keeping the lights on and covering payroll.
But the tricky thing about business, especially when you’re just starting, is that it’s very hard to say no. You accept every meeting, phone call, and every bit of work that comes your way.
Even if you know in your heart and on paper that it might just break-even or dip into the red, you’ll say yes to the work because you never know if it would lead to something bigger.
My newly formed ‘Yes Man’ approach, while well-intentioned, turned out to be completely flawed. As my business took off and revenue soared, I was losing money. Although sales were growing, profit margins were being squeezed due to discounting to win work.
What’s worse, our service quality dipped as client expectations veered off course. Frustrations brewed, and customers began heading for the exits faster than we could say ‘welcome’. In this chaotic whirlwind, I found myself losing more customers than I was gaining.
My financial and mental health took a hit. I was working myself to the bone – 14 hours a day, 7 days a week – too overwhelmed to see where I was going wrong.
Now, don’t get me wrong, it would’ve been somewhat acceptable if we were raking in the profits. But the truth was that it wasn’t. Despite my business consistently doing 20% month-on-month revenue growth (which is impressive growth for any business, irrespective of industry or size), I was bleeding money. I was shackled to an unprofitable customer servicing model, a relentless profit-losing machine of my own creation.
I was stuck, and it was time for a change.
As our business spiraled into chaos, we knew change was our only way out. So, my business partner and I decided to step away from the daily grind for a Sunday afternoon, put on our business owner hats, and take an unflinching look at our company’s financial performance.
What we uncovered validated our gut feeling: our business was a disaster. The irony stung because our mission was to help other firms with their financial performance, yet I couldn’t seem to get it right for us.
‘How ironic,’ I thought to myself. I felt like an imposter.
I shook off that emotional state and let my rational, System 2 brain take the reins, starting with a deep dive into customer profitability.
Our analysis revealed a startling truth: the profits from the top 20% of our customers were being drained by the losses from the bottom 80%!
In other words, our lack of selectivity when choosing ideal customers was sabotaging our own success.
Being a perpetual ‘yes’ person was slowly but surely killing our business.
And chances are, it’s doing the same to yours.
Your practical guide to customer profitability analysis
Analysing the profitability of your customers can be a game-changer for your business. Here’s a step-by-step guide on how we conducted our customer analysis. (I’ve tried my best to document all the steps, but if you get confused or lost – feel free to reach out.)
Step 1: Start by exporting a sales report from your accounting system to a spreadsheet. Filter the data by customer name and the dollar value of sales over the previous 12 months.
Step 2: For each customer, ask yourself the following questions.
- Are they easy to work with?
- Do they pay their bills on time?
- Are they a brand ambassador or influencer for your product or service?
- Do you genuinely like them as people?
For the first three questions, assign a score from 0 to 3 (0 being terrible, 3 being amazing).
The fourth question should be a simple binary choice, 0 or 1.
Tally your results, which will give you a qualitative score out of 10 for each customer.
This process of allocating a score against each question will help you to assess customers objectively and eliminate any biases you may have towards your customers.
Step 3: Calculate the average direct cost to service each customer and enter this value in a new column. You can pull this information from your time-sheet data or project management system.
Step 4: Calculate the gross profit earned from each customer and calculate the gross margin by subtracting the average costs to service each customer from the sales dollars.
Step 5: Filter the spreadsheet by the gross profit dollars of each customer and their ranking from Step 2. This will provide you with a list of your most profitable and most desirable customers – the ones you’d want to clone.
The table above is a sample customer profitability analysis for a fictitious company called Voltage Media.
Here are the key observations:
- Customers marked under ‘Note 1’ are the customers you should fire. They have low customer scores and are not profitable. It’s time to let them go.
- ‘Note 2’ highlights customers that are a little less binary. This company brings in significant revenue and has high customer scores, but they are serviced unprofitably. In situations like this, dig deeper to identify the underlying issues causing the lack of profitability. Perhaps you’re over-servicing them or not producing their work efficiently? Use this as a prompt to unearth the underlying issue.
- Customers under ‘Note 3’ are in the middle ground – neither exceptionally profitable nor unprofitable. You can keep them, but monitor their performance over time.
- Customers who score well on the customer scale, and bring in substantial profits are the real gems. These clients often compensate for losses from others. These are the customers you want to replicate and nurture.
How to fire a bad client
In the 24 hours that followed our eye-opening customer analysis, I found myself making a series of straightforward yet emotionally taxing decisions that would dramatically transform my business. I resolved to part ways with the unprofitable 80% of our customer base.
My outreach email was something like this:
Me: Hey customer, I’m reaching you to inform you of a few internal changes at our company. We’ve spent the last 12 months servicing our customers of all shapes and sizes, from startups to larger businesses. To date, we’ve been flexible to cater for all these different businesses as we want to help as many businesses as possible. As you can appreciate, being tailored for everyone does come at a cost. After reviewing our service offering and the associated fees, we are changing our prices. Your account will fall into the new package at $XX per month. I can appreciate this comes at a higher price, and this investment will ensure we’re able to continue to maintain our level of service.
Please reach out if you have any thoughts on the above. If I don’t hear from you in the next 10 days we’ll assume you’re comfortable with the new arrangement.
Customer: I must say it is not an appealing proposition at all. As we have always been dealing with this issue, we fail to see what is different now and more surprising how it can double the monthly cost of the service you provide to us.
Me: I agree nothing has changed since engaging us, however our recent review showed we cannot service you profitably at the current rates. I hope you appreciate this doesn’t make business sense for us. I can refer you to a cheaper alternative if you wish. Let me know and I can make the introduction.
As expected, a handful of customers chose to part ways and accepted our referral to another service provider. What surprised us was that the majority accepted the price increase, and continue to be customers of ours today.
By offering clear options – pay a higher rate or switch to a cheaper alternative – we simplified the decision-making process for our customers, eliminating the need for lengthy negotiations. It turns out that customers appreciate straightforward choices. They’re busy people too.
The net result was that we actually increased revenue because the price hike compensated for the loss of unprofitable clients. Removing these burdensome customers set the stage for efficient, sustainable growth. With fewer customers but higher profitability, we gained more time and, most importantly, reduced stress.
As business owners, we often find ourselves buried in the daily grind, overwhelmed and stressed about the state of our businesses. If you’re looking to grow but don’t know where to start, begin by evaluating your existing customers.
It may seem counterintuitive to sack customers in the quest for revenue and profitability growth, but sometimes, to move forward, you must first get your house in order.